What to do about Household Debt?
It’s a funny old economy we live in. The release of today’s national balance sheet accounts has aroused great concern about the rise of the ratio of household debt to personal disposable income to a new record of 148%. Mark Carney and our banks want – quite rightly – to discourage further borrowing to prevent a disaster for highly leveraged households as and when interest rates rise, or unemployment rises.
Meanwhile, on the asset side, households and unincorporated businesses are sitting on a mountain of cash and short-term deposits to a total of $946 Billion, or about one quarter of all financial assets.
It seems that those with money are sitting on big piles of cash earning next to no interest, while those without it are borrowing far too much.
We need much more information on the incidence of debt across the wealth distribution. Yes, savers tend to be older than borrowers, but there is much more to it than that as shown by episodic surveys of wealth. Those at the top of the wealth and income spectrum have much, much greater net financial assets than those at the middle and bottom.
Could it be that an appropriate policy response to the rising indebtedness of lower and middle income households, especially younger families with big mortgages, might be to increase income transfers such as child benefits and earned income tax credits , paid for by higher income taxes on the high income earners who are most likely to be big savers?
With the economy still operating well below potential, should we not remember the Keynesian insight that it is stimulative to transfer resources from those with a low propensity to consume, to those with a high propensity to consume?
In short, rather than lecture often struggling households about taking advantage of those low interest rates to stay afloat, maybe Mark Carney, Jim Flaherty and Bay Street should be out there talking about the merits of using the tax/transfer system in a re-distributive way to shift resources from those sitting on cash, to those who would surely spend it if given the chance?
Just asking.
The propensity to consume argument is iron clad. It does not seem to have impressed the Liberals when they were in government. What about now? The Bloc should be on board, and the NDP as well.
I have argued on rabble that deflation is the issue, in the way inflation became the issue over thirty years ago. The debt overhang is the main cause.People paying down debt slow consumption. Any further interest rate hike spells deepening trouble.
Major re-distribution should be on the table to fight deflation. The AFB will make that point I suppose.
Perhaps, too, Carney might remember that it was the willingness of the average Canadian to take on massive amounts of debt–mostly mortgage debt–that got us through the recession; businesses were, and remain today, nowhere to be seen. As Jim Stanford pointed out here recently, the risk to our economy is that we will stop borrowing and spending, and begin paying off personal debts. When that happens–and Carney might have started the ball rolling–we will see just how resilient the Canadian economy is.
it is a double edged sword for sure. However I do agree very very much with Duncan, the campaign for a paradigm shift to fighting deflation has never been fully implemented by business, govt and consumers.
Without that shift, picking on consumers is hardly a helpful strategy, it could lop off our defending appendages.
Andrew,
Hear, Hear; Mr Speaker.
I do say the moralistic tone of our times is rather frightening…what with the Victorians running the place and all…Bedlam!
Carney is not an elected politician, it is not his job to decide how the tax system should be setup. Neither is Wall Street elected.
Our elected MP’s should be the one’s clamouring for such things. But not one, of any party, has been.
Using redistributive tax/social programs to respond to consumer indebtedness has several merits. I would like to situate this discussion in terms of longer term trends in real wages. IF your real wages are stagnant, it is not a big surprise that -for a while at least- you cope via debt. From this perspective , one might regard consumer debt as that which takes the pressure off demands for higher real wages (and in turn the necessity of servicing debt makes workers more vulnerable, thus further eroding their bargaining power to demand higher real wages). Yeah for consumer debt! – it helped the neoliberal model have a good run of it for quite some time (irony, folks).
My take home message from the real wages story: If we don’t have an economy in which economic growth delivers rising real wages, perhaps we need to share the fruits of economic growth via public policy.
There are other helpful consequences of contextualizing the consumer debt problem in light of what has been happening with real wages for more than a generation. There is a moralistic undertone (and sometimes overtone) in vilifying consumers as spendthrifts. This gets even more odd when – often on the same page of the newspaper- economists and policy makers wring their hands in fear that consumers might not spend enough. Consumers are both heros/oines (thou shall spend money and help the economy) and villains (thou has sinnist if thy debt load increased in order to spend that money). But if consumer debt is one ramification of a wage problem, perhaps we can shift this debate off of the “blame consumers†message.
There is further reason that I am concerned about this tendency to blame consumer debt exclusively on consumers. Borrowers require the consent of lenders in order to go into debt- nobody put a gun to the poor financial institutions to force them to lend. Financial institutions have embraced all kinds of lucrative activities that had the entirely foreseeable effect of intensifying debt problems among consumers. How about some stern public lectures to financial institutions about their activities in promoting the current consumer debt situation. And what pain should they endure to contribute to the solution?
But you don’t understand! See, consumers are supposed to all have that perfect “homo economicus” thing going which will allow them not only to know exactly how their future will work out, but also allow them to instantly solve all collective action problems and generally do the perfect thing rather than just acting like isolated individuals. If they wilfully ignore economic theory and insist on making non-optimal decisions it’s clearly their fault.
Financial institutions with billions and billions of dollars, on the other hand, couldn’t possibly be expected to figure out the implications of all of them taking the same short-sighted actions. I mean, even after all the mergers and takeovers, I’m sure there’s enough of them left to make at least a moderate-sized industry association–how can anyone expect such a huge number of firms, probably in the *dozens*, to communicate or plan? Waste time on that kind of stuff and next quarter’s bonus could be in jeopardy!
Absolutely thanks for this article. Somebody please explain to Flaherty this:
1). Compound interest looks nice only on paper. In reality it became almost impossible for households to earn positive real returns on their investments, especially risk-free or with moderate amount of risk. Very few households can afford the risks of investing in todays economy, where everything is too risky, even if it’s just a 90-day, A-graded commercial paper…:)
2). The reason that the households are not saving and getting in debts is not that they do not understand compounding interest, but that they have no choice. Young people just out of school can not get any jobs at all. So they go to the universities and graduate with tens of thousands of debt. And then again they can not find jobs, because nobody wants to hire new graduates and train rookies. And even if they are lucky to get a job they get paid what? Like a huge salary of $25 000 – $ 30 000 a year to start with? Just to rent a decent appartment costs $ 12 000, they need at least $10 000 for food, transportation and other basic personal expenses and what they have left they pay in taxes. Where do they have money to save or repay their debts? And if they have any emergency (such as Christmas Holidays) they have no choice but to get more in debts. And God knows what they are supposed to do when they get subject of the next “restructuring” and loose their jobs!
And if people are prevented from borrowing then the economy will not grow, because nobody will be able to buy anything. Flaherty seems to know at least that.
And with economy in depression, falling real incomes and rising unemployment rates tings only can get worse and the situation just can not get fixed by simply teaching people no-longer existing compounding interest (currently equal to 0%).
I am very scared that with the governments, who do not undertstand the finances of their citizens beyong the most basic compounded interest concept the world economy at this time is a ticking debt bomb.
Liberalism allows rich to get rich, but it does not seem to know what to do witheveryone else, who inevitabbly gets empoverished by enriching few.
A credit on the books of one indevitably becomes a debit in the books of others if the economy works the way it works today.
Bible talks a lot about dangers of borrowing and lending money. I think it this is for a good reason. It looks like history already has known numerous examples, when accumulating debt on one side and accumulating wealth on the other side has led to disastrous results.
Traditionally older people were helping the young, their kids and transferring wealth from old to the young without borrowing. Now a lot of people do not have kids and they do not feel obligated to help the young. As a result, wealth of the old and debt of the young is piling up.
It could be a necessary thing, given that with time we will have more and more old and fewer and fewer young. And it is also the result of the tough situation fo the young.
Where, exactly, is the evidence for this claim that households are leveraged because they are poor? American households were highly leveraged yet the USA was not exactly a third world nation while this leverage was underway. If the thesis held I would expect that household leverage would be inversely related to median per capita GDP and looking at international comparisons I don’t see that.
The link is between debt and inequality, not level of income, Brian
See the IMF study –
http://www.progressive-economics.ca/2010/11/30/worker-bargaining-power-and-the-crisis/
It’s not a Keynesian argument to transfer income from high savers to low wavers to stimulate the economy. It’s a Kaleckian argument: Kalecki combined Keynes’s aggregate demand model with a structuralist model of income distribution (between investor-savers and worker-spenders). Keynes’s world is largely classless (despite his hatred for rentiers); Kalckei’s is not. Andrew’s fine argument is thus Kaleckian, not Keynesian.
Jim wrote:
“Keynes’s world is largely classless”
Largely in agreement although a close read of the GT reveals a view that the main obstacle to solid analysis was the warping of classical political economy via the exclusion of income distribution and class analysis. Keynes makes almost the exact same distinction (although not in the same terms) between classical political economy and the vulgar apologetic line developed after its apogee. This line he hangs quite rightly on Pigou. On this read Kalecki takes the marxist instinct and brings it to the fore in Keynesian type setting in fairly relaxed and effortless manner.
The problem of aggregate demand when diagnosed as the propensity to consume which crashes in a liquidity/deleveraging crisis points in the direction of a redistribution of income from savers to debtors. This is I think why for example Krugman finally understands that neoliberalism is flawed and austerity no remedy. Like a good school boy Keynesian though he has to get there via the liquidity trap and deleveraging and not by starting with a class analysis of income distribution.
I we democratised the CB we could give citizens access to better debt consolidation facilities and effectively transfer some the consumer creditors profits to the public while increasing the capacity of workers to de-lever without cutting consumption.
Of course that is like saying if a bus had turbines and wings it could be a plane.